A tax by any other name

President Obama has faced little difficulty in selling the biggest component of his tax policy- the expiration of the Bush tax cuts. Given the massive amount of spending we’ve seen in the last two months, the fact that Democrats control the entire federal government, and the not-to-be-underappreciated fact that Obama campaigned on killing the tax cuts, everyone knew this was coming. Republicans are gamely fighting it, but one suspects they secretly welcome a fiscal debate that offers this much clarity. The lapsing of the Bush tax cuts represents a straightforward, old-fashioned tax increase. It is something the public can understand and clearly support/oppose, something they couldn’t do during the expedition into fiscal androgyny known as TARP or the drunken scrum known as the stimulus package.

Given rising concerns over federal debt levels and the redistributive spirit that always seems to accompany economic recessions, the public largely supports phasing out the Bush tax cuts. At the same time, Obama is finding out how hard it is to camouflage tax increases the public doesn’t support. His proposal to decrease tax deductions for charitable contributions was lambasted by non-profits and ridiculed by Congress. His attempt to fast-track carbon taxation through the Senate ran into a brick wall of moderate democrats, and the surprisingly sophisticated public has worked backwards through the math and realized that the home mortgage bailout plan will inevitably push credit costs higher for everyone else, while creating another federal deficit stream that will need to be funded by increased taxation.

In summary: 1) Americans don’t feel they shouldn’t be taxed for money that they give away to others 2) they don’t like being taxed to change their energy consumption behavior when they're in the middle of a recession and viable alternatives don’t exist, and 3) they don’t like paying their neighbor’s mortgage. Go figure.

This week saw the beginning of another new taxation proposal that the public will likely find just as endearing- taxing health care benefits as income. Ironically, during the campaign this idea was floated by the McCain campaign, and quickly became fodder for attack ads from the Obama campaign. The ads failed to note that McCain’s plan called for tax credits to partially offset the new tax, but even if they had it probably wouldn’t have made the proposal any more palatable. The public hated the idea, and if Obama travels down this path he will find that he has indeed become a post-partisan leader. Both the U.S. Chamber of Commerce and the SEIU oppose the idea, which would mark the first time they were on the same side of an issue since, well, I don’t know, WWII.

You can’t blame Obama or his coterie of highly-intelligent-yet-socially-handicapped economic advisers. The proposal makes economic sense. Non-taxation of health care benefits has resulted in an arms race for employers and contributed to skyrocketing health care costs for the entire economy.

For example, let’s say you are a small manufacturing company and you are negotiating a new contract with your line workers. If their base salary level is $40,000, than for every additional $100 you increase it, after backing out a 25% income tax, 7.5% social security tax, medicare, state and local taxes, your employees will only end up taking home about $65 of the $100 you paid out. If instead you offer $65 in health care benefits, your employees would get the same utility, while you as a company would pocket the $35.

Unfortunately you don’t get to keep that $35. The market recognizes your newfound windfall, so your insurance companies and health care providers keep increasing their prices until you find that the marginal cost of providing another cent of health care to your employees is the same as the marginal cost of another cent of salary. At the same time, it has artificially raised the cost of health care by $35 for everyone in the system, which especially impacts those people who have to buy their own insurance.

In a conservative’s ideal world, we wouldn’t have taxes so this imperfection wouldn’t exist. In a Scandinavian’s ideal world, there are no taxes, because the government runs the system and imperfection is a given. Here in real-world America, there is a middle course available to President Obama. Tax health care benefits, but do it at a lower rate than income taxation. A health care benefits tax of 20%, phased in over three years (vis-à-vis tax credits to both individuals and businesses) would be a good target. At this low level, you would get some of the economic benefits and a degree of political solvency for the plan.

One more thing…it should be a flat tax. If we are shooting for a world in which equal access to equal health care is a “universal right” shared by every American, then $100 of health care should have the same economic utility for every American, irrespective of their income level. A household comprised of schoolteachers making $70,000 a year gets the same utility from $100 of birth control and Propecia as does a household comprised of a two investment bankers. OK, that was a bad example. Instead of investment bankers, how about two pawn shop brokers?